ASSIGNMENT DMBA 202 FINANACE MANAGEMENT

1.
“Financial planning is essential for any organization or individual looking to achieve
financial stability and growth. The process involves a series of structured steps that help
in setting, monitoring, and adjusting financial goals”. Explain in detail the steps
involved in financial planning, highlighting how each step contributes to a successful
financial strategy of a company. Additionally, discuss the various factors that can
impact the financial plan of an organization.

ANSWER
2.2 Steps in Financial Planning There are six steps involved in financial planning. Figure 2.1
depicts the steps involved in financial planning.

Let us now study the steps in detail. Establish corporate objectives – The first step in
financial planning is
to establish corporate objectives. Corporate objectives can be grouped
into two:
o Qualitative and quantitative objectives
o Short-term, medium-term, and long-term objectives
For example, a company’s mission statement may specify “create economic – value added.”
However this qualitative statement has to be stated in quantitative terms such as a 25% ROE
or a 12% earnings growth rates. Since business enterprises operate in a dynamic environment,
there is a need to formulate both short-term and long-term objectives. Formulate strategies
– The next stage in financial planning is to
formulate strategies for attaining the defined objectives. Operating plans
help to achieve the purpose. Operating plans are framed with a time
horizon. It can be a five-year plan or a ten-year plan.
Assign responsibilities – Once the plans are formulated, responsibility
for achieving sales target, operating targets, cost management
benchmarks, and profit targets are to be fixed on respective executives.

Forecast financial variables – The next step is to forecast the various

financial variables such as sales, assets required, flow of funds, and
costs to be incurred. These variables are to be translated into financial
statements.
Financial statements help the finance manager to monitor the deviations
of actual from the forecasts and take effective remedial measures. This
ensures that the defined targets are achieved without any overrun of
time and cost.
Develop plans – This step involves developing a detailed plan of funds
required for the plan period under various heads of expenditure. From
the plan, a forecast of funds that can be obtained from internal as well as
external sources during the time horizon is developed. Legal constraints
in obtaining funds on the basis of covenants of borrowings are given due
weightage. There is also a need to collaborate the firm’s business risk
with risk implications of a particular source of funds. A control
mechanism for allocation of funds and their effective use is also
developed in this stage.
Create flexible economic environment – While formulating the plans,
certain assumptions are made about the economic environment. The
environment, however, keeps changing with the implementation of plans.
To manage such situations, there is a need to incorporate an in-built
mechanism which would scale up or scale down the operations
accordingly.

2.3 Factors Affecting Financial Planning Figure 2.2 depicts the various factors affecting
financial plan.
Let us now discuss these factors in detail. Nature of the industry – The first factor
affecting the financial plan is
the nature of the industry. Here, we must check whether the industry is a
capital-intensive or labour-intensive industry. This will have a major
impact on the total assets that a firm owns.
Size of the company – The size of the company greatly influences the
availability of funds from different sources. A small company normally
finds it difficult to raise funds from long-term sources at competitive
terms.
On the other hand, large companies like Reliance enjoy the privilege of
obtaining funds both short-term and long-term at attractive rates.
Status of the company in the industry – A well-established company
enjoys a good market share, because its products normally command
investor’s confidence. Such a company can tap the capital market for raising funds in
competitive terms for implementing new projects to exploit the new opportunities
emerging from changing business environment. Sources of finance available –
Sources of finance could be grouped
into debt and equity. Debt is cheap but risky whereas equity is costly. A
firm should aim at optimum capital structure that would achieve the least
cost capital structure. A large firm with a diversified product mix may
manage higher quantum of debt because the firm may manage higher
financial risk with a lower business risk. Selection of sources of finance is
closely linked to the firm’s capability to manage the risk exposure.
The capital structure of a company – The capital structure of a
company is influenced by the desire of the existing management
(promoters) of the company to retain control over the affairs of the
company. The promoters who do not like to lose their grip over the
affairs of the company normally obtain extra funds for growth by issuing
preference shares and debentures to outsiders.
Matching the sources with utilisation – The prudent policy of any
good financial plan is to match the term of the source with the term of the
investment. To finance fluctuating working capital needs, the firm resorts
to short-term finance. All fixed-asset investments are to be financed by
long-term sources which is a cardinal principle of financial planning.
Flexibility – The financial plan of a company should possess flexibility
so as to effect changes in the composition of capital structure whenever
the need arises. If the capital structure of a company is flexible, there will
not be any difficulty in changing the sources of funds. This factor has
become a significant one today because of the globalisation of capital
market.
Government policy – SEBI guidelines, finance ministry circulars,
various clauses of Standard Listing Agreement and regulatory
mechanism imposed by FEMA, and Department of Corporate Affairs
(government of India) influence the financial plans of corporates today.
Management of public issues of shares demands the compliances with
many statutes in India. They are to be complied with a time constraint.
2.
a)XYZ India Ltd.’s share is expected to be Rs.450 one year from now. The
company is expected to declare a dividend of Rs. 25 per share. What is the
price at which an investor would be willing to buy if his or her required
rate of return is 15%?
ANSWER

To calculate the price at which an investor would be willing to buy the share of XYZ India
Ltd., we can use the Dividend Discount Model (DDM) for a one-period scenario. The
formula for the price of a stock under this model is:

P0=D1+P1(1+r)P_0 = \frac{D_1 + P_1}{(1 + r)}

Where:

 P0P_0 = Current price of the stock

 D1D_1 = Dividend expected to be paid in the next period (Rs. 25)
 P1P_1 = Price of the stock at the end of the period (Rs. 450)
 rr = Required rate of return (15% or 0.15)

Substituting the given values:

P0=25+450(1+0.15)P_0 = \frac{25 + 450}{(1 + 0.15)} P0=4751.15P_0 = \frac{475}{1.15}

P0=413.04P_0 = 413.04

Therefore, the price at which an investor would be willing to buy the share is Rs. 413.04.

B. Differentiate between Operating and Financial leverage.

ANSWER:
Operating Leverage and Financial Leverage are two important concepts in business
that reflect how a company uses fixed costs to amplify its profitability. Here's a
differentiation between the two:
1. Operating Leverage:
o Definition: Operating leverage refers to the use of fixed operational costs
in a company’s cost structure. Companies with high operating leverage
have a larger proportion of fixed costs relative to variable costs.
o Impact: It magnifies the effect of changes in sales on a company’s
earnings before interest and taxes (EBIT). A company with high operating
leverage will see a more significant increase in profitability when sales
rise, but it can also face greater losses if sales fall.
o Example: A company with expensive machinery (fixed costs) but low
variable costs for production has high operating leverage.
2. Financial Leverage:
o Definition: Financial leverage refers to the use of borrowed funds (debt)
to finance the acquisition of assets. A company with financial leverage
uses debt to increase the potential return to its equity holders.
o Impact: It magnifies the effect of changes in EBIT on the company’s
earnings per share (EPS). If EBIT increases, financial leverage can lead to
a higher return for equity holders, but it can also increase financial risk if
EBIT falls.
o Example: A company taking loans to finance expansion is using financial
leverage.
In summary, operating leverage affects profitability through fixed operational costs,
while financial leverage amplifies returns (or losses) through the use of debt. Both
leverage types can lead to higher returns, but also increase financial risk.

3.
A company has the following capital structure:

Equity Capital: 10 crore shares of Rs.10 each, fully paid up.

9% Preference Capital: 1 lakh shares of Rs.100 each, fully paid up,
redeemable after 8 years.
15% Debentures: 2 lakh debentures of Rs.100 each, redeemable after 5
years.
12% Term Loans: Rs.20 crores.

Additional information:

The next expected dividend on equity shares is Rs.4 per share, with an
annual growth rate of 6%. The market price per equity share is Rs.50.
The market price of the preference shares is Rs.90 per share.
The market price of debentures is Rs.85 per debenture.
The company’s income tax rate is 35%.
Requirement: Compute the Weighted Average Cost of Capital (WACC)
using the market value approach.

ANSWER:
SET2

4.

A company is considering, the following mutually exclusive projects:

Cash Flows (in Projects

₹)
Q R S
𝐶0 -25000 -25000 -25000
𝐶1 10000 7000 10000
𝐶2 13000 11000 10000
𝐶3 11000 13000 10000
𝐶4 7000 10000 10000
C0 represents initial investment and C1, C2, C3, and C4 are annual cash
inflows in the year 1,2,3 and 4 respectively.
Assuming a 12% discount factor, estimate the net present value of
projects Q, R, and S. Which project should be recommended under the
net present value (NPV)method?
The present value factor (PVF) @ 12% is as follows:
Year 1 2 3 4
12% 0.893 0.797 0.712 0.636

ANSWER

To determine the Net Present Value (NPV) for each project (Q, R, and S), we need to
discount the cash flows of each project at the given discount rate (12%) using the provided
Present Value Factors (PVF).

Formula for NPV:

NPV=∑(Ct(1+r)t)NPV = \sum \left( \frac{C_t}{(1 + r)^t} \right)

Where:

 CtC_t = Cash flow at time tt

 rr = Discount rate (12% in this case)
 tt = Time period (1, 2, 3, or 4)

Alternatively, since the PVFs are given for each year, we can directly multiply the cash flows
by the corresponding PVFs and sum them.

Present Value Factors (PVF) at 12%:

Year 1 2 3 4
PVF 0.893 0.797 0.712 0.636

Now, let’s calculate the NPV for each project.

Project Q:

Cash Flows for Project Q:

 Initial Investment (C0C_0) = -25,000

 Year 1 Cash Flow (C1C_1) = 10,000
 Year 2 Cash Flow (C2C_2) = 13,000
 Year 3 Cash Flow (C3C_3) = 11,000
 Year 4 Cash Flow (C4C_4) = 7,000

NPV Calculation for Project Q:

NPVQ=−25000+(10000×0.893)+(13000×0.797)+(11000×0.712)+(7000×0.636)NPV_Q = -
25000 + (10000 \times 0.893) + (13000 \times 0.797) + (11000 \times 0.712) + (7000 \times
0.636) NPVQ=−25000+8930+10361+7832+4452NPV_Q = -25000 + 8930 + 10361 + 7832 +
4452 NPVQ=−25000+28475=3475NPV_Q = -25000 + 28475 = 3475

NPV for Project Q = ₹3475

Project R:

Cash Flows for Project R:

 Initial Investment (C0C_0) = -25,000

 Year 1 Cash Flow (C1C_1) = 7,000
 Year 2 Cash Flow (C2C_2) = 11,000
 Year 3 Cash Flow (C3C_3) = 13,000
 Year 4 Cash Flow (C4C_4) = 10,000

NPV Calculation for Project R:

NPVR=−25000+(7000×0.893)+(11000×0.797)+(13000×0.712)+(10000×0.636)NPV_R = -
25000 + (7000 \times 0.893) + (11000 \times 0.797) + (13000 \times 0.712) + (10000 \times
0.636) NPVR=−25000+6251+8767+9256+6360NPV_R = -25000 + 6251 + 8767 + 9256 +
6360 NPVR=−25000+23634=−366NPV_R = -25000 + 23634 = -366

NPV for Project R = ₹-366

Project S:

Cash Flows for Project S:

 Initial Investment (C0C_0) = -25,000

 Year 1 Cash Flow (C1C_1) = 10,000
 Year 2 Cash Flow (C2C_2) = 10,000
 Year 3 Cash Flow (C3C_3) = 10,000
 Year 4 Cash Flow (C4C_4) = 10,000

NPV Calculation for Project S:

NPVS=−25000+(10000×0.893)+(10000×0.797)+(10000×0.712)+(10000×0.636)NPV_S = -
25000 + (10000 \times 0.893) + (10000 \times 0.797) + (10000 \times 0.712) + (10000 \times
0.636) NPVS=−25000+8930+7970+7120+6360NPV_S = -25000 + 8930 + 7970 + 7120 +
6360 NPVS=−25000+30380=5380NPV_S = -25000 + 30380 = 5380

NPV for Project S = ₹5380

Summary of NPVs:
 NPV of Project Q = ₹3475
 NPV of Project R = ₹-366
 NPV of Project S = ₹5380

Recommendation:

Under the Net Present Value (NPV) method, the project with the highest positive NPV
should be selected. Therefore, Project S should be recommended because it has the highest
NPV of ₹5380.

5.
Explain in detail the theory of the MM approach to capital structure in the
presence of taxes and absence of taxes.

ANSWER
7.4.4 Miller and Modigliani approach Miller and Modigliani criticise traditional
approach that the cost of equity remains unaffected by leverage up to a reasonable limit
and K0 remains
constant at all degrees of leverage. They state that the relationship between leverage and
cost of capital is elucidated as in NOI approach. Table 7.6 depicts the assumptions
regarding Miller and Modigliani (MM) approach: perfect capital markets, rational
behaviour, homogeneity, taxes,
and dividend payout.
Let us now discuss these assumptions in detail.

Perfect capital markets – Securities can be freely traded, that is,

investors are free to buy and sell securities (both shares and debt instruments), no hindrances
on the borrowings, no presence of transaction costs, securities are infinitely divisible, and
availability of all required information at all times.

Investors behave rationally – They choose the combination of risk and

return which is most advantageous to them. Homogeneity of investor’s risk perception –
All investors have the
same perception of business risk and returns. Taxes – There is no corporate or personal
income tax.
Dividend payout is 100% – The firms do not retain earnings for future
activities.

Summary of the MM Approach

Without Taxes:

 The capital structure has no effect on the firm's value.

 The value of the firm is determined by its operating income, and its total value
remains the same regardless of whether the firm is financed by debt or equity.

With Taxes:

 The value of the firm increases with debt due to the tax shield on interest payments.
 The optimal capital structure would involve as much debt as possible because it
maximizes the value of the firm by providing the tax shield on debt.
 The cost of equity increases as debt increases, but the firm's weighted average cost of
capital (WACC) decreases due to the tax shield on debt.

Conclusion:

 MM without taxes: Capital structure does not affect the firm’s value.
 MM with taxes: The use of debt increases the value of the firm due to the tax shield
on interest payments, and there is an optimal capital structure with more debt
financing.

However, the MM theory assumes perfect markets and ignores real-world considerations
such as bankruptcy costs, agency costs, and other market frictions that can affect capital
structure decisions. Despite these assumptions, the MM approach provides an important
framework for understanding how financing choices can impact a firm's value.
6.
Efficient cash management will aim at maximizing the cash inflows and slowing cash
outflows. Discuss the statement in light of effective cash planning opted by the
organizations.

ANSWER:
12.6 Cash Planning We discussed the two models that are used in determining the
optimal cash needs of a firm. Let us now discuss cash planning and its objectives. Cash
planning is a technique to plan and control the use of cash. Cash planning helps in
developing a projected cash statement from the expected inflows and outflows of cash.
Cash planning has three main objectives: Ensure that expenditures are smoothly
financed during the year, so as to
minimise borrowing costs.
Enable the initial budget policy targets, especially the surplus or deficit,
to be met.
Contribute to the smooth implementation of policies in place.
An effective cash planning and management system should: Recognise the time value
and the opportunity cost of cash.
Enable all internal segments/departments to plan the expenditure
effectively.
Be proactive–anticipating economic developments while accommodating
significant economic/industry-specific changes and minimising the
adverse effects on budget execution.
Be responsive to the cash needs of all segments/departments.
Be comprehensive–covering all inflows of cash resources.
Plan for the liquidation of both short- and long-term cash liabilities.
Even if the budgets prepared are realistic, well-prepared and objective, it does not
necessarily mean that its implementation will be smooth. Timing issues can be expected
between payments coming due and the availability of cash necessary to discharge them.
An ideal cash plan should include, for example a month ahead, a daily forecast of cash
outflows and cash inflows. A set cash plan can instil confidence within the firm that they
have cash control. A system can be put in place whereby a continuous monthly updating
of the cash plan takes place. This would help ensure that the initial budget targets
are met. When it is clear from a latest forecast available, that targets may
not be met in the future or at the end of the year, measures can be taken to
constrain expenditure or to increase revenues. The cash plan can contribute to the
decisions on the size, type and targeting of the measures required. Forecasts are based
on the past performance and future anticipation of events. Cash planning can be
performed on a daily, a weekly or a monthly basis. Generally, monthly forecasts and
cash plans are commonly prepared
by firms.

Conclusion:
Efficient cash management is essential for the survival and growth of a business.
Maximizing cash inflows and slowing cash outflows are two complementary strategies
that can help maintain liquidity, reduce financing costs, and provide a cushion for
unforeseen expenses. By effectively planning and forecasting cash flows, negotiating
favorable payment terms, and optimizing operational expenses, organizations can
achieve an optimal cash position that supports long-term financial health.